The negative impact of the 2008 financial market decline and the 2008 and 2009 recession pushed many hospitals' financial condition into the "zone of insolvency." While no bright-line test exists to determine when a hospital has entered this zone, the evaluation involves a combination of legal and financial tests.

At this stage, the hospital is neither fiscally sound nor in bankruptcy proceedings. The American Hospital Association's August 2009 survey, The Economic Crisis: Ongoing Monitoring of Impacts on Hospitals, reported that nearly 10 percent of hospitals surveyed indicated they had a bond covenant financial default.

It is extremely difficult for these providers to access capital through traditional strategies, such as bank loans, asset-based lending, leasing or tax-exempt borrowing. They are challenged to finance investments in new technology and facilities, patient safety and quality, and new services and programs, which are essential to address regulatory and commercial market performance requirements. A "rehabilitation" of their balance sheets will be required, and it will neither be an easy nor quick journey. Other hospitals whose financial condition is stronger than those in the zone of insolvency may still be evaluated as noninvestment grade (typically considered as 80 days or less cash on hand and a debt service coverage ratio of less than 2.0) and may face similar access to capital challenges, particularly access to tax-exempt borrowings. Health reform legislation is expected to have a positive near-term financial impact on hospitals, but it will not provide the financial relief needed by highly distressed providers.

The response to this financial crisis depends on the specific financial circumstances of each organization, but generalizations can be made based on the institution's financial position. While many hospitals are embarking on a journey to rehabilitate their balance sheet, others—including many who are enjoying their best financial performance in recent years—are playing offense by opportunistically acquiring distressed assets and investing in markets where competitors are struggling to keep pace on access, service and quality. Others are trying to determine their "sustainable bet" strategy, identifying areas of clinical excellence that will position them for long-term financial viability. The chart on Page 28 depicts some of the typical responses by organizations based on their current financial wherewithal.

This analysis offers some perspectives on turnaround strategies that we believe are more important than ever to consider. While the sense of urgency is greatest among non-investment grade hospitals, these ideas are applicable to all providers irrespective of their current financial condition.

The status quo of all business models should be challenged and providers should reassess their strategies for continuing relevance and likelihood of facilitating sustainable financial performance. Implementing innovative and dramatic changes in operations, financing methods, service lines, sites of care, and people and governance will be essential to sustaining financial performance and mission-driven success. Health care reform will likely accentuate this disruption and fuel the need for strategic re-evaluation and change.

The Rehabilitation Journey

Providers should begin their accelerated financial rehabilitation by making an honest assessment of their situation and objectively answering tough questions such as:

  • What is our hospital's competitive position? What are the realistic projected financial results under a "status quo" scenario?
  • What is the level of financial performance improvement needed to obtain access to capital? Is it achievable?
  • What is the hospital's range of options to achieve strong, sustainable financial performance?

Not until these answers are known and explored will governance, management and other constituencies understand the magnitude of the change required to position the organization for sustainable financial success. Clarity regarding the requirements for success should begin to form, and a picture should emerge about the level and type of change needed in the way the hospital operates.

Creative Solutions

Today's financial rehabilitation requires rethinking the usual turnaround strategies and taking a more comprehensive perspective and approach to creating and implementing turnaround solutions; thinking shouldn't be limited to just financing tactics such as debt modifications. Following are some potential turnaround strategies for consideration. Some are tested but not frequently implemented and others are more innovative and emerging. While "one shoe doesn't fit all," each of these ideas merits consideration. Each requires an open mind and a willingness to not just accept the status quo. If a provider's balance sheet is to be rehabilitated to levels expected by creditors, a serious evaluation of the following turnaround strategies should be undertaken.

Financing Strategies: While the rehabilitation shouldn't be limited to financing tactics, providers should consider vigorously pursuing certain financing strategies. In a turnaround, all aspects of the business should be evaluated as a potential source of capital. Virtually all operating areas, both direct patient care and infrastructure, can be a source of capital accessed by entering into financing arrangements. For example, providers have entered into financial transactions involving the lab, IT, physical therapy, medical office buildings, the parking garage and imaging.

The resistance to leveraging these assets as sources of capital has typically been loss of control; however, this risk can be mitigated by service-level agreements and termination clauses. Ceding financial control doesn't necessarily mean ceding quality control and oversight. The search for resources should not be encumbered by historical precedent. Value exists all around us. We just need to recognize its existence and capitalize on its potential. The emerging view is that capital can be sourced from all our assets, both tangible and intangible. Stated differently, all assets should be in play as a potential source of capital.

Another potential financing tactic is pursuing the development of public-private partnerships around either key lines of business or areas of operation. Perhaps strange bedfellows, but on an increasingly frequent basis, private and public organizations are coming together to form public-private partnerships to pursue common objectives.

Commonly referred to as PPPs, these ventures infuse government capital with private market expertise. Formed through the creation of special purpose entities, PPPs are much more prevalent in other countries and U.S. industry sectors than in U.S. health care. A blank sheet of paper exists for providers to collaborate with the public sector and provide an expanded source of capital and collectively address needs that will emerge due to health care reform or current challenges, such as care of the uninsured. President Obama called upon the public and private sectors to enhance their dialogue around ways to better collaborate. Some examples of potential public-private partnership ideas that are emerging include:

  • Emergency response network operations;
  • Information repositories to improve the quality of care and lower costs;
  • Programs to manage chronic diseases;
  • Financing of replacement facilities; and
  • Creation of clinics to provide low cost access to care.

Operations Strategies: Operational changes are usually a primary driver of the financial rehabilitation. A wide variety of strategies are being implemented across areas such as supply chain, care coordination and management, fixed costs and contracting.

Care Coordination and Management: One idea is to improve the management of care through strategies such as operating clinics to provide free care in lieu of uninsured patients using costly emergency department care. Patients with nonemergency care needs can be triaged to a clinic setting with longer clinic hours to mitigate off-peak emergency room usage. While not new, this tactic is underutilized. Each provider should consider conducting an analysis of the net benefit of operating a clinic designed to support the uninsured. Also, many providers have entered the retail medicine area in an effort to reduce high-cost ED utilization.

In a related vein, this cost benefit analysis should also evaluate the merits of creating a care management process for the uninsured and others, such as patients with chronic diseases, who frequently use the emergency room. These patients typically require a disproportionate level of resources that can potentially be reduced through care coordinators who follow up with the primary attending physician to develop care plans designed to reduce the utilization of services. This cost benefit analysis involves modeling the cost of providing care to the uninsured that could perhaps be avoided through enhanced care coordination versus the unfunded cost of the care expected to be rendered in the absence of effective care coordination.

Fixed Costs: Providers should consider adopting a paradigm that all costs are variable. Financially distressed providers should view all costs as controllable and every cost should be evaluated for its direct benefit to patient care and critically challenged as to whether it adds value or just cost. Each cost pool, particularly in those functions that don't flex their cost structure based on volume changes, should be evaluated as to whether it can be changed from a fixed to a variable cost. Costs that are typically subject to "restructuring" to a more variable cost characteristic typically include all purchased and professional services. Zero-based budgeting should be considered for each budget cycle. In addition, a critical review of all policies and practices should be conducted in an attempt to identify ones that unnecessarily burden the organization or create unnecessary costs.

Managed Care Contracting: The health insurer is viewed as having the data in the managed care contracting negotiation process, making it difficult for the provider to optimize its position in the negotiation because their arguments aren't fact based. It is more imperative than ever that providers consider investing to capture information that supports their ability to negotiate a fair payment rate based on the facts relative to costs and margins under managed care contracts. Providers need to know their real costs of care to negotiate payment because while you "get what you negotiate" you need to know what you are negotiating for and why.

Supply Chain: While clearly a time-tested strategy, some current factors are enhancing the relevance of lowering supply costs. Bundled episodic payments are an outcome of health reform. This involves, for example, a single payment for an inpatient stay, including the professional component. The incentives for physicians will be aligned to pursue supply chain improvements. Also, advanced supply chain process analysis techniques are demonstrating enhanced improvements in this area for providers who previously believed there were only nominal savings still attainable. These techniques include refinements in supply team selection, problem-solving techniques, measurements and status reporting.

Other key actions that are being pursued include a renewed focus on product standardization that can then add more leverage to vendor contract negotiations as well as implementing more caps for high-cost items; that is, the maximum price paid for a similar product to any vendor.

Accounts Receivable Cash Acceleration: Experience suggests that providers do not take advantage of some of the tools available to increase the availability of cash. Even relatively small hospitals can generate significant increases in up-front cash collections simply by knowing how much to ask the patient to pay at the time of service. Most patients come to the hospital knowing that they have to pay a portion of their bill. Enhanced software is now available to assist registration and admitting in determining patient co-pays in a real-time mode. Asking for the correct amount up front can reduce future billing costs, reduce bad debts and potentially increase cash without adversely impacting patient satisfaction. In fact, patient satisfaction can be increased because the wave of billings sent to patients following their care is dramatically reduced.

Management and Governance: Turnarounds are not an easy business. You not only need the whole organization with you, but the process is not without pain and the risk of losing your top-performing talent is real. It is incumbent on management to engage the workforce in the turnaround and to reward personnel for their contribution to the turnaround's success. Everyone needs a sense of purpose, to feel ownership of the change process and an understanding of the way forward. Not many boards commit up front to sharing the turnaround's economic success with the employees. This commitment can result in everyone helping to source ideas in support of improved financial viability.

You can't "deal" your way out of a crisis. It frequently requires organizational discipline. Creating this type of culture is not the enjoyable or glamorous part of management, but if it isn't well done, there will not be time to move beyond crisis to the strategic and innovative aspects of managing a turnaround. Management should make sure all leaders are vigilant in focusing on the details and consistently reinforce with managers and associates what their priorities are and the importance they play in achieving the organizational goals. The board and management should be prepared to make difficult decisions and once made, to stay the course.

Physician Alignment: The future of health care is headed toward greater physician integration. Some physician practices want to be purchased by health providers. The turnaround's success can be enhanced by the involvement of the medical staff and mechanisms to align the interests of the hospital, and the physicians should be at the forefront of the turnaround effort. It is imperative that physicians be involved in the build-out of the turnaround strategies. Contemporary strategies in this area include comanagement agreements and gain-sharing arrangements.

The Way Forward

The financially distressed or at-risk provider should consider a planning process that will achieve consensus on the provider's baseline financial performance given current environmental factors and strategic priorities. This baseline financial performance should identify capital deficits and gaps in performance compared with credit market financial benchmarks.

Next, the provider should develop a set of options, including the vital strategies set forth above, to work toward achieving sustainable financial performance. The scenario planning should consider, where appropriate, combinations of options as well as varying assumptions responsive to key planning variables such as Medicare, Medicaid and managed care payment rate changes, supply cost inflation and other similar variables.

Finally, a roadmap, based on the results of the scenarios, should be developed to return the organization to sustainable financial performance. The blueprint can address the risks and related critical success factors to achieving the improved financial performance and form the basis for the development of change management strategies, including communication plans.

Sustaining the Change

Sustainability is always the critical question. Experience suggests some actions that are often critical in this regard:

  • Refresh the strategy on a regular basis. The market is dynamic, and reform may well accelerate the changes that providers need to implement.
  • Focus on a limited number of service offerings; you may not be able to be everything to everyone.
  • Target solid margin generating services. Market share growth doesn't always mean profitable growth. The ability to cost shift or obtain subsidies will likely diminish, so being profitable on your own is important.
  • Consider joint ventures, particularly where you believe services are essential but sufficient scale is difficult to achieve.
  • Quality of care and investments that directly support quality should be the long-term plan. This supports your contracting, branding, and physician retention and recruitment plans.

Crisis and Opportunity

While the financial crisis and recession impaired the financial condition of many providers, it created the opportunity to step back and rethink the business model. The disruption in the financial markets also made it imperative to be able to access credit on the strength of the hospital's own creditworthiness, not simply through credit enhancements.

This is the time to embark on a journey of financial rehabilitation. It will take time and patience, but it can be accomplished. The old adage of "no margin, no mission" is now "no financial strength, no access to capital." These strategies may help you achieve the financial strength necessary to be able to access the capital markets and therefore fund those needed investments as you work toward achieving sustainable financial performance.

Robert Clarke (robclarke@deloitte.com) is a partner with Deloitte Financial Advisory Services LLP and national practice leader for the Health Sciences & Government Industry, Chicago. Bruce Buchanan (bbuchanan@hcmpllc.com) is a managing director with Healthcare Management Partners LLC, Phoenix.

Sidebar - Turnarounds or Takeovers?